Thursday, October 4, 2012

Why Romney Contributes to My Doubts About the Ability of Reputation Effects to Police Markets

My intent here really isn't specifically to bash Romney, but rather to observe how little potential reputation effects are altering the strategy of a man that spent most of his life at the top of the business world.

This seems to be a decent frame to me for several reasons. The Presidential race involves a great deal more information and transparency than is normally the case for most consumer product decisions in the market. Potential competitors have high incentives to distribute information about competitor's past actions and ability to adhere to promises. The impacts on a consumer of making a poor decision is potentially very large, consumers have a strong incentive to verify the accuracy of the information presented and base their judgments on past history. In addition, there is no clear price signal to induce consumers to take a gamble on one competitor over another, the decision must be made based on competing claims and the competitor's reputation.

Yet, we see no significant effort to build up a positive reputation (in the economic sense, not personal). Romney has not made any significant efforts to make credible claims (in the sense of claims he can be held to). He tries to promise everything to everyone. This is especially obvious with regards to his tax plan. It is certainly possible to lower rates for everyone, lower taxes on the middle class, keep the tax burden on the wealthy constant, and to keep this deficit neutral by eliminating deductions and credits; however, it is not possible to do this while keeping faith on earlier claims, such as a 20% rate reduction on all groups, lowering taxation on investments, and not increasing the corporate tax rate. Yet there is every sign that these inconsistencies are not hurting him.

Now, there isn't a perfect parallel between markets and an election, but it seems curious that a prominent businessman doesn't seem to be acting as if reputation effects were something that was normative for him. If markets were self-policing due to reputation effects, it is not a big jump to believe that someone that spent most of their lives in business would have internalized these norms. Instead, it seems that he feels that he can promise to act on principles with regards to tax policy, even if these principles as a whole are mutually contradictory.

While interesting, this isn't really surprising. I suggest reading on the scandals regarding early medications in the 18th and 19th centuries. People were willing to purchase harmful junk for a very long time based on incredible claims. People also showed a very strong desire for a 3rd party to adjudicate these claims, though initially this just made things worse in the form of patent medicines since the patent gave the illusion of government approval even if the patent process of the time didn't require any proof of efficacy. There's no particularly good evidence that reputation effects are all that powerful in general, though they can be in specific circumstances, and Romney's actions are entirely consistent with a realistic businessman's appraisal of the situation. But it needs to be noted that what the real businessman is doing in action runs counter to the ideological cover given by some of his ideological fellow travelers regarding the market's ability to police itself. I think the normative behavior on display is very telling regarding America's real business culture stripped of its philosophical justifications; though it does make me less certain than ever about how Romney would govern.*

*My personal opinion is that there are essentially two outcomes. Either Romney is making credible claims to his donors, or he is making credible claims to the electorate. Since Romney has appointed people to his campaign that express a strong belief in an economy driven by investors and entrepreneurs rather than one driven by more systemic characteristics (like availability of skilled workers, strong social networks, social supports to mobilize marginal workers, etc.) I find it more credible that he would favor donors, gambling that his economics is right and favoring them would lead to innovation and growth. However, I do feel some doubt based on his record in Massachusetts, but it is plausible that his long term ambitions led him to moderating his governing in hopes of higher office down the road where he could more fully express his governing philosophy. I'm on the fence really, and would prefer not to find out which scenario is true, with the caveat that I think the make up of the House and Senate may be more determinative of which Romney we end up seeing.

2 comments:

While Romney was prominent in business, it was a very different kind of business from the ones you are talking about when you speak of reputational effects.

A consultant (or an M&A guy) deals primarily with audiences who do not talk to each other. That means he can come in and advise one thing to one client, and something completely opposite to the next one. Neither will probably announce that they took a consultants advice, let alone announce what it was or the benefits or losses from doing so.

What that means is that, in spite of his business success, Romney's experience would tend to lead him to exactly the opposite of the concern for reputation that you expect. He would think it entirely usual to say one thing to one group, and something totally different to another. Not differences in emphasis, which all politicians (and all salesmen, for that matter) do. But complete contradictions, if that's what they want to hear.

What does that means for how Romney would govern? I suspect that he would be almost entirely externally driven. If a majority of Republicans in Congress passed something, he would not hesitate to sign it. If he was talking with a foreign leader, he would tend to say whatever that leader wanted to hear -- and then say the opposite the next week, with never a thought to what reaction that would incur. In short, Romney would not be an "honest politician" -- that is, his word would be worthless. And as everybody rapidly discovered that, his ability to accomplish anything (as opposed to being a rubber-stamping) would disappear.

I think you hit the nail on the head: reputation effects are powerful in certain circumstances but not most. As I said when Goldman was settling with the SEC for $500m in 2011: if pure comparative capitalism works, Goldman Sachs will lose its clients. That's an industry where what you describe in terms of negative mixed with positive reputation does not seem to significantly affect the principal.

And I think there's something revealed by that: the bigger the entities you're choosing against, whether GOP vs Dem or Barclays vs Goldman, the more you'll choose to see negative reputation as singular transgressions that won't affect you. In politics, you may choose to believe that not only "every politican lies," but even that the negative reputation might be entirely false.

To your larger point, I think that consumers have an intrinsic, if undefined, idea of the truthfulness of sales pitches in various situations. If I'm weighing mortgage offers, I am counting on the details to be ironclad. If I'm comparing which light beer is going to give me more of a rockin' party based on the commercials, I know not to expect too much. Sadly or not, politics falls into that latter category of mostly fluff.